Prepayment of sales tax deferral loan on payment of net present value of future liability cannot be classified as remission or cessation of trading liability
In brief :-In a recent ruling, in the case of Sulzer India Ltd. Vs. Jt. CIT [2010-TIOL-670-ITAT-MUM-SB] , the Special Bench of the Mumbai Income-tax Appellate Tribunal (the “Tribunal”) held that prepayment of deferred sales tax liability on the Net Present Value (“NPV”) of the future liability cannot be classified as remission or cessation of the trading liability, so as to attract the provisions of section 41(1)(a) of Income-tax Act, 1961 (“the Act”).
The assessee company had obtained incentives by way of sales tax deferral schemes under the package scheme of incentives 1983 (“1983 scheme”) and package scheme of incentives 1988 (“1988 scheme”), notified by the Government of Maharashtra. Under the 1983 scheme, the assessee’s unit at Kondhapuri was entitled to defer the payment of sales tax collected during the period of 1 November, 1989 to 30 October, 1996 (seven years) and this amount would become payable after 12 years in six equal installments. The assessee collected sales tax of INR 32.99 million during the period to be repaid after 12 years in six equal installments. Under the 1998 scheme, which was similar to 1983 scheme, the amount of sales tax deferred was INR 42.21 million Thus, the aggregate deferred sales tax amount under the 1983 and 1988 schemes was INR 75.20 million. The deferred sales tax collected by the assessee was treated as an unsecured loan in its books of account.
The sales tax collected was claimed and allowed as a deduction under section 43B of the Act in view of the Central Board of Direct Taxes (“CBDT”) Circular No. 496 dated 25 September, 1987, which provides that deferral of sales tax under the 1983 and 1988 schemes shall be treated as paid for the purpose of section 43B of the Act.
There was an amendment made to the Bombay Sales Tax Act, 1959 (“Sales Tax Act”) whereby the deferred sales tax was to be converted into a loan (third proviso to section 38(4) of the Sales Tax Act), and an option was provided for the settlement of the deferred sales tax liability by prepayment at NPV (fourth proviso to section 38(4) of the Sales Tax Act). The assessee opted for prepayment of the deferred sales tax liability at NPV and, accordingly, paid an amount of INR 33.71 million, representing NPV of INR 75.20 million.
The amount of INR 41.49 million, being the difference between the deferred sales tax liability and its NPV, was treated as a capital receipt and was credited to the capital reserve account in the books of account of the assessee.
The Assessing Officer (“AO”) treated the difference of Rs. 41.49 million as remission of the sales tax liability, and considered it chargeable to tax under section 41(1) of the Act.
On first appeal, the Commissioner of Income-tax (Appeals) upheld the addition made by the AO and held that prepayment of the deferred sales tax liability/loan at NPV resulted in remission of the liability in the hands of assessee, and therefore, the amount was taxable under section 41(1) of the Act.
The assessee filed an appeal before the Mumbai Tribunal and a Special Bench under section 255(3) of the Act was constituted to address the issue.
Whether the quantum difference between the prepayment of future liability at NPV and the future liability itself would amount to remission or cessation of trading liability, and therefore, taxable in terms of section 41(1)(a) of the Act, or would be treated as capital receipt not liable to tax.
The assessee contended that:
• Section 41(1) of the Act is attracted where a benefit is obtained by the assessee. In the present case, the assessee has discharged the future deferred sales tax liability of INR 75.20 million by making payment of its NPV of INR 33.71 million. Therefore, no benefit was obtained by the assessee. The benefit should be understood in commercial terms and not by a mathematical difference.
• The amount of INR 75.20 million was treated as ‘Deferred Sales tax Loan’ in the assessee’s books of account. Therefore, any benefit received in respect of this was a capital receipt.
• Though the amendment to the Sales Tax Act applies to prepayment of a deferred sales tax liability, the proviso applies to all cases where a ‘certificate has been granted for availing incentives by way of deferment’. This is wide enough to cover cases of deferment whether the amount has been converted into a loan or not.
• The deferred sales tax incentive under the 1983 and 1988 scheme was similar to the incentive granted under the 1979 Package Scheme. The Special Bench in the case of DCIT v. Reliance Industries Ltd.  88 ITD 273 (Mum) (SB) has held that the incentive under the 1979 Package Scheme is a receipt on capital account, and therefore, the assessee’s case is squarely covered by the Special Bench decision. Reliance was also placed on the decisions in the cases of CIT v. Ponni Sugars and Chemicals Ltd.  306 ITR 392 (SC), ACIT v. Associated Capsules Ltd. (ITA No.4818/Mum/08) (Mum), Everest Industries v. ACIT (ITA No.814/Mum/2007) (Mum), etc. to contend that the sales tax incentive is a capital receipt and section 41(1) of the IT Act does not apply to a benefit received on capital account.
• The benefit, if any, obtained by the assessee was not in respect of the sales tax deferral liability but in respect of prepayment of a loan. Therefore, the benefit, if any, of such prepayment is on capital account. In this regards reliance was placed on the decision in the case of S.I. Group India Ltd. v. ACIT  192 Taxman 91(Bom).
The Revenue contended that:
• The assessee was treating sales tax collected as part of trading income and not as a capital receipt in its books of account. The statutory auditor had categorically stated ‘NIL’ under column 13(e) of the assessee’s Tax Audit Report which provides for ‘amounts not credited to the Profit & Loss Account being capital receipts’. Therefore, sales tax receipts cannot be treated as capital receipts.
• The deferred sales tax incentive was not given to enable the assessee to set up the unit or for the creation or purchase of capital assets, but was in the nature of operational subsidies, i.e. the assessee was entitled to the sales tax subsidy only after, and conditional upon, commencement of commercial production. Therefore, such subsidies must be treated as assistance for the purpose of the assessee’s trade and revenue in nature. Reliance was placed on the decisions in the cases of Sahney Steel & Press Works Ltd. v. CIT  142 CTR 261 (SC), CIT v. Ponni Sugars and Chemicals Ltd.  306 ITR 392 (SC), CIT v.Abhishek Industries Ltd.  286 ITR 1 (P&H).
• Prepayment of the sales tax liability was not part of the initial ‘Package of Incentives’ scheme, but a separate scheme floated by the Government. Thus, it was only a business arrangement between the State Government and the assessee for prepayment of the sales tax liability and therefore cannot be entertained.
• The contention that the deferred sales tax liability was converted into a loan is not acceptable since the necessary modification to the ‘Eligibility Certificate’ was not carried out by the sales tax authorities. Further, the argument that assessee had applied for conversion and therefore it should be deemed that conversion had been approved cannot be accepted. The decision of CIT v. Mrs. Hilla J.B. Wadia  216 ITR 376 (Bom) which was relied upon by the assessee is misplaced and not relevant to the facts of the case.
• The application for conversion of the deferred sales tax liability into a loan was filed with State Industrial and Investment Corporation of Maharashtra Ltd. (“SICOM”) on 8 October, 2010 and therefore, the question of treating it as a loan before this does not arise. Additionally, the entries in the books of account were not determinative of the nature of transactions. Even if accepted, conversion of the deferred sales tax liability does not alter the character of the liability in the hands of the assessee. Reliance in this regard was placed on the decision in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v. CIT  227 ITR 172 (SC).
• The sales tax liability is fixed the day it accrued. It cannot diminish over a period of time unless it is paid or the person to whom the liability is owed gives up/waives/remits part of the liability. The present liability of INR 75.20 million is a fixed liability which was to be discharged at a specified future date.
• The contention that by making prepayment of the deferred sales tax liability, the assessee is deprived of cash in praesenti, and hence, there cannot be any benefit, is not tenable since the assessee opted for prepayment only because it was beneficial to it.
• The assessee has been allowed deduction of the deferred sales tax liability under section 43B of the Act, and finally, the assessee has only paid INR 33.71 million as against the deduction of INR 75.20 million claimed. The balance liability of INR 41.49 million is not required to be paid now, or in the future. Therefore, benefit has been obtained by the assessee to an extent of INR 41.49 million and, therefore, the condition in section 41(1) of the Act is satisfied.
Special Bench Ruling
The Special Bench of the Mumbai Tribunal held that:
• The first condition to invoke the provisions of section 41(1) of the Act is that an allowance or deduction has been made in respect of loss, expenditure or the trading liability incurred by the assessee. In the present case, the assessee had obtained the benefit of deduction of sales tax liability under section 43B of the Act in accordance with CBDT Circular No. 496 dated 25 September, 1987. However, the benefit of deduction was allowed for the purpose of section 43B of the Act only, and not under any other provisions of the Act. Accordingly, the first requirement of section 41(1) had not been fulfilled.
• The dictionary meaning (From www.BusinessDictionary.com) of NPV provides that the present value of a future sum is the same and if there is a difference, positive NPV means a better return and negative NPV means a worse return. The assessee had paid an amount of INR 33.71 million to SICOM which, according to assessee, was the NPV determined by SICOM. No material has been placed on record by the revenue to show that the NPV of a future sum is not the same or in the process of calculation of the present value of a future sum there is any conversion gain to the assessee.
• The judicial cases relied upon, by both the revenue and the assessee, were not relevant as they were dealing with the issue of whether the subsidy received is a capital receipt of revenue in nature, whereas the matter in hand was whether the difference in the deferred sales tax liability is chargeable to tax as business income under section 41(1) of the Act.
• The assessee had paid the NPV of the deferred sales tax liability payable after 12 years in six equal installments and no refund was received by the assessee in that process. Therefore, there is no iota of evidence to show that the assessee had obtained any benefit in respect of that trading liability by way of remission or cessation of liability by the State Government.
• Merely because the sales tax authorities had not issued the modified ‘Eligibility Certificate’ did not mean that the payment of INR 33.71 million made by the assessee cannot be accepted as having been made at the NPV of the future sum of INR 75.20 million towards discharge of the full liability. Merely because the assessee had passed the necessary entries in the books of account, it cannot be held that there was any cessation or remission of liability.
• Remission is possible only in prasenti and not in the future. Thus, payment of the NPV of a future liability cannot be classified as remission or cessation of the liability to attract section 41(1)(a) of the Act. In this regards reliance was placed on section 63 of the Indian Contract Act, 1872 and Commentary by Pollock & Mulla, Thirteenth Edition of the Indian Contract Act.
Conclusion:-The Special Bench ruling has applied the principle of commercial advantage to hold that where a liability payable in the future is settled at NPV, no benefit or remission arises since the NPV represents the equivalent value of the future liability.